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Determining an accurate market value for your company

Formulate a basic idea by applying key criteria that buyers, lenders use


By Ed Kirk
SPECIAL TO THE JOURNAL OF BUSINESS

Ed Kirk, Principal
The value of a privately held company can be calculated in so many different ways that the answer to the question “What is my company worth?” depends a great deal on whom, and why, you are asking.

An owner having his or her company valued for tax or estate planning reasons, for example, typically will receive a different answer than one who has a company appraised for banking purposes, and while both of those measures of value are valid, neither is reflective of the company’s value when the owner decides to sell.

For most of the 23,000 owners of privately held companies in the greater Spokane area, the question of value is likely to be a practical one. Myriad equations and theoretical frameworks promise to determine the value of any business, but owners who intend to sell in the future really only need one number: the price their company will fetch on the market when it’s time to cash in.

A clear understanding of market value enables owners to plan confidently for retirement. In contrast, misperception of value can lead down a rocky path. The story of the owner who believed his or her company was worth more than the market was willing to pay has been repeated countless times; it almost always ends with a sad choice between delaying retirement and compromising retirement lifestyle.

To avoid such a decision, owners should determine the market value of their companies as early as possible and revisit these valuations about once a year. Owners are advised not to pursue a sale until the amount they net, after taxes and other costs, is enough to meet their financial goals for the next phase in life.

The sale price of a company depends on two separate, but closely related factors—what a buyer is willing to pay, and how much a bank is willing to lend to finance the acquisition. The buyer who purchases a company out-of-pocket is rare; even private equity acquirers with large war chests of cash typically use leverage to finance up to 80 percent of the price of companies they acquire. Almost every deal therefore will be required to pass the muster of a lender’s underwriting department, and the amount an acquirer is willing and able to pay ultimately will depend in part on how much they are able to borrow for financing the acquisition.

Banks will look at the assets available within the company to collateralize the loan, as well as the acquired company’s ability to service the debt with cash flow. Regardless of collateral assets, lenders and buyers alike want the company to maintain a reasonable cash flow cushion—perhaps 25 percent—beyond the amount needed to keep up operations, pay management salaries, and service loans.

As a starting point, it is worthwhile to note that most companies sell for a multiple of two to six times earnings before interest, tax, depreciation and amortization (EBITDA), which typically translates into a return on investment of 16 percent to 50 percent for the acquirer. Exactly where a particular company falls on this spectrum depends heavily on the following factors:

Management. Acquirers want an investment that will continue to grow and prosper even when the company’s founder departs. Having a strong, tenured management team that can run the business successfully after the ownership transition adds to the value of a company.

Diversification. Single products or large customers that contribute disproportionately to sales or profits may imply risk to acquirers and their banks. Companies whose revenue comes from a broad array of customers, products, and geographic regions often sell for higher multiples.

Competitive or strategic benefits. Companies with strong, sustainable competitive advantages are valued highly. Acquirers are buying a company’s potential, and a strong strategic vision indicates a promising future.

Predictability and potential for growth. Buyers generally perceive less risk with companies whose revenues and profits are very predictable. They also see more upside with companies that have significant growth potential. In either case, acquirers may be willing to accept a lower return, which translates into a higher price for the seller. By contrast, acquirers generally want a higher return when they perceive greater risk, and the result for the seller is a lower price.

Assets. Banks often are more comfortable lending money to finance the purchase of asset-intensive companies. If the business takes a turn for the worse, this collateral can be sold off to repay the bank debt. Moreover, some acquirers appreciate asset-rich companies for the competitive barrier that the assets provide. On the other hand, asset-intensive companies require greater expenditures to fuel growth and therefore are not as attractive to some buyers.

These broad guidelines should help any owner begin to formulate a basic idea of the market value of his or her company. Pinpointing market value with more precision is a complex task that might fairly be called equal parts science and art. Ultimately, a company’s price tag will be impacted by a combination of customers, suppliers, employees, market conditions, management, competition, consistency of cash flow, assets, contracts, quality of financial records, and many intangibles that fall under the category of “goodwill” and take years to develop.

Advisers who have seen dozens if not hundreds of transactions are an excellent source of information on market value, and reputable firms generally don’t charge for market valuations. Owners who are seriously considering a future sale should make a point of narrowing the valuation range, preferably with professional help, to enable accurate retirement planning.

Ed Kirk, a Spokane native and Gonzaga University graduate, is a principal at ASG Partners, a Seattle-based regional merger-and-acquisition firm specializing in the sale of privately owned manufacturing, distribution, and service businesses. Ed can be reached at 425-450-4800 or ed@asgpartners.com

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